The Great Refinancing Cycle Is Upon Us
All we keep hearing is that the precipitous decline in our interest rates means a dramatic economic slowdown/recession is on the horizon in the U.S. Nope! Au contraire. Our longer duration rates have declined as foreigners have been buying our debt with both hands as interest rates abroad are much lower/even negative than here. That also explains the strength in the dollar. All of this is so obvious by just watching the global flow of funds.
Since money is the fuel for economic growth, that also explains why economies where capital is fleeing, like in the Emerging Markets, Japan and the Eurozone, are weak. Even if our inflation rate was 1.5% for another 10 years, which is dubious, our 30-year bond still should not be yielding just 2% today. Our longer-term rates will continue under pressure as long as rates abroad remain much lower than here. And don’t forget that we also expect the Fed to reduce the funds’ rate by at least another 50 basis points before year-end despite continued 2+% economic growth for the foreseeable future.
Why do we remain so optimistic that the U.S. will continue to grow so strongly as global growth continues to decelerate? Our consumer is in great shape and our government continues to spend like drunken sailors. And that’s 90% of our economy. So why get your head bent out of shape over trade and tariffs? Even if all the tariffs were raised to 25%, the maximum cost per family would be slightly above $1000. Did you even consider the overall benefit if only 40% of the $9.4 trillion of household mortgage debt was refinanced down 1 percentage point? The benefit would be over $4000 per household. And what if half of the $15 trillion in business debt was refinanced down 1 percentage point? And then there is the U.S government, state and local debt too! Get the point of where we are going with this?
The great refinancing cycle is just beginning and the cumulative positive effects on our economy are huge. You even heard Mnuchin mention last week that the government is considering issuing ultra-long bonds. About time! Here is another fact to consider: the dividend yield on the S and P is well above the 30-year Treasury bond. That means that many corporations could issue debt, get the deductibility of interest costs against taxes, shrink their capitalization, accordingly, reduce their aggregate dividend expense as fewer shares will be outstanding and end up increasing their cash flow/share too. Remember Buffett’s valuation matrix comparing earnings yield to interest rates? Our market remains undervalued today. But not all stocks will do well for all the reasons mentioned over the last few months. Active managers should outperform as we continue to do.
Let’s look at last week’s key data points that confirm or detract from our view that the U.S remains the best place to invest until there is a real resolution of the key global trade conflicts. A ceasefire may lead to short term rallies, like last week, but really won’t change business sentiment/spending/hiring until hard deals are finalized.
- The U.S consumer remains the driving force in our economy: personal consumption expenditures increased 0.6% in July; disposable personal income increased 0.3%; personal income increased 0.1%; the PCE price index increased 0.2% (1.4% from a year ago), and personal savings rate remain elevated at 7.7% or $1.27 trillion. While consumer confidence remained at a lofty 135.1 in August, consumer sentiment fell to 89.8. The bottom line is that the consumer remains in great shape and that does not include a mortgage refinancing boom that we are expecting over the next several months. We were pleasantly surprised to see that overall corporate profits actually rose 4.8% from the prior quarter and was up 1,5% from a year ago despite continued sluggishness in the manufacturing sector. The U.S economy remains in excellent share bolstered by strong consumer demand along with huge fiscal stimulus. And consider the added benefits if the great financing cycle begins in earnest!
- We certainly were pleased that China held off retaliating against the new U.S tariffs. The truth remains that China needs a trade deal more than we do as corporations accelerate their supply lines movements away from China to other, lower cost, Asian countries. China’s manufacturing sector deteriorated further in August with the purchasing managing index dropping to 49.5. The non-manufacturers index, which is less than 40% of China’s economy, held at 53.8. A sub-index gauging new export orders remained at a weak 47.2 in August. While we expect the government to introduce more stimulus packages, we still believe that growth will slow to 6% or less next year without a trade deal with the U.S. China 2025 remains at risk.
- The Eurozone remains a mess as the Euro tumbled to a 2-year low on Friday. While we expect the ECB to introduce a major new stimulus package on September 11, it won’t help much without major fiscal stimulus programs which won’t happen overnight. We remain pessimistic on the U.S reaching a trade deal with the Eurozone. We also believe that the chances of a hard Brexit by the end of October continue to rise. Why invest in Europe? It’s cheap for a reason.
- It appears that Japan and the U.S have reached a trade deal. While it is positive as it ends the risk of higher car tariffs on Japanese exports, it is not the panacea that will ignite growth in Japan. Interestingly, the Japanese yen has remained relatively strong as it is now considered a safe haven currency, but negative interest rates are more telling of the real weakness of the Japanese economy. There is not much that the BOJ can do at this point nor can the government afford a major stimulus package. We continue to avoid investing in Japan.
- We were disappointed that growth in India slowed to a six-year low of only 5% last quarter. Unfortunately, India’s banks have a debt problem that is restraining lending that has led to weakness in private consumption and business spending. While we like the prospects of India, we are not investing there at this time.
The bottom line remains that there is no place like home. We remain convinced too that Trump will do all in his power to stimulate the economy and boost the stock market prior to the Presidential election next year. Will he introduce a lower/middle income tax reduction utilizing the tariff receipts? We think so to mitigate any punitive impact on those who could afford the least the price hikes caused by the tariffs.
We do not believe that the U.S and China will conclude a trade deal before elections next year. At the same time, we believe that the odds of a ceasefire are rising too. While a ceasefire will be met with a relief rally, it won’t be the panacea to unleash business spending until a deal is finalized.
While we continue to maintain a defensive posture, we continue to work on an options strategy adding great companies that have a cyclical bent, strong cash flow and above average dividend yields. Our portfolios are currently concentrated in consumer non-durable companies, communication, technology companies without much exposure to China, utilities, some retail companies including those concentrated in the housing sector, healthcare, cable with content, airlines and many undervalued special situations. Also, we own gold stocks as a hedge against escalating geopolitical risks. Finally, we own no bonds, are flat the dollar and maintain above average cash levels.
Remember to review all the facts; pause, reflect and consider mindset shifts; look frequently at your asset mix with risk controls; do independent research and …
Paix et Prospérité LLC